- Analysts at Macquarie Capital Markets say US private sector debt levels are at multi-decade lows.
- As a result, the economy will be able to withstand a further increases in interest rates before it shows signs of contraction.
The prospect of higher US bond yields has been in focus this year as the Fed continues forward on its rate-hiking cycle.
It’s led many analysts to question how high interest rates can go before US economic growth begins to stall.
Some point to the rising US fiscal deficit — which now looks set to top $1 trillion as soon as next year — as an indicator that the US is vulnerable to higher rates.
But according to Macquarie Capital Markets analysts David Doyle and Neil Shankar, such a view is akin to “missing the forest for the trees”.
In fact, the US economy “still has ample capacity to absorb higher interest rates”, the pair said. And it’s all to do with the private sector.
While public sector debt has risen significantly over the past decade, private sector debt has actually done the opposite:
“Private sector debt to GDP has fallen nearly 70 percentage points from its peak and is at the lowest level since 2001,” the pair said.
At the same time, the equivalent ratio for public sector debt has risen by 40 basis points.
Such a scenario may be a handbrake for growth if the government was enacting tighter fiscal policy, but instead the US government has a big fiscal stimulus plan in place for the next two years.
Regardless, the pair said the debt-to-GDP measure is flawed because it compares a measure of “stock” (total debt at a given point in time) to a “flow” (GDP, which is measured over time intervals).
A more accurate approach would be to calculate total interest paid on the debt, relative to GDP.
“Here the numbers are even more supportive of the notion that there is ample scope for rates to rise further,” Doyle and Shankar said.
“Total economy interest paid to GDP has nearly been cut in half since 2007 and is at the lowest level since 1969.”
The pair said that using the most recent data available, total interest paid comprised just 18% of GDP in 2016.
They added that their observation holds true across all private sub-sectors, and even the federal government is paying historically low rates of interest when measured against GDP.
As a result, they expect the Federal Reserve to continue raising rates until the federal funds rate
As a result, they expect benchmark US 10-year treasury yields to rise to 3.75% by the end of next year.
It’s a view that contrasts significantly with analysts at Morgan Stanley, who expect US 10-year yields to fall to 2.5% over the same period.
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